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Strategic Management Week 13 – Chapter 12

Mergers & Acquisitions

Chapter 12 Learning Objectives

• Describe different types of mergers and acquisitions (M&A). • Estimate the return to the stockholders of a bidding and target firm when

there is no strategic relatedness between the two firms. • Describe the different sources of relatedness between bidding and target

firms. • Describe the reasons for acquisitions when no value is created to the

shareholders of the bidding firm. • Describe the major challenges of integrating acquisitions.

Where Are We in the SM Process?

Mission Objectives

External Analysis

Internal Analysis

Strategic Choice

Strategy Implementation

Competitive Advantage

Business Level Strategy

Corporate Level Strategy

How to Position a Business

in the Market?

Mode of Entry?

Vertical Integration? Diversification?

M&A?

Which Businesses to Enter?

The Choice between Market and Hierarchy

BENEFITS

COSTS

MARKET HIERARCHY

Informational Efficiencies

High-Powered Incentives

Transaction Costs

Market Power

Authority

Coordination

Bureaucracy

Agency theory

Source: Collis and Montgomery, Corporate Strategy, 1997

Defining Acquisitions

• Simple: when one firm purchases another • What would qualify as a purchase here?

– Purchase of closely/privately-held ownership stake – Purchase of target firm’s assets – Purchase of publicly-traded shares

– Means of purchase • Through cash/cash equivalents (typically not other assets) • Through debt • Through equity

Accounting Considerations

• Ownership level • 100% • Majority (≧51%) • Controlling share (plurality of voting interest); “Ability

to exercise significant influence” – Method: Consolidation? Equity vs. Cost

» Goodwill/goodwill impairment – VIEs (owner is “primary beneficiary”)

Logic of Corporate Level Strategy Corporate level strategy should create value:

2) such that businesses forming the corporate whole are worth more than they would be under

independent ownership

3) that equity holders cannot create through portfolio investing

• a corporate level strategy should create synergies that are not available in equity

markets

• vertical integration = value chain economies

1) such that the value of the corporate whole increases

Why?

• Create economic value (not the average result): – Economies of scale

• To achieve this a small acquisition premium (e.g. acquisition offer less: pre-announcement market value) and acceptable broker/advisor/legal/interest cost would likely be necessary

– Economies of scope • Accessing complementary resources and capabilities • Leveraging existing resources and capabilities

Lubatkin Motivators for M&A’s (Bidding Firm Perspective) [See Table 12.3]

• To reduce production or distribution costs: – 1. Through economies of scale. – 2. Through vertical integration. – 3. Through the adoption of more efficient production or organizational tech. – 4. Through the increased utilization of the bidder's management team. – 5. Through a reduction of agency costs by bringing organization-specific assets

under common ownership. • Financial motivations:

– 1. To gain access to underutilized tax shields. – 2. To avoid bankruptcy costs. – 3. To increase leverage opportunities. – 4. To gain other tax advantages. – 5. To gain market power in product markets. – 6. To eliminate inefficient target management.

Why?

• When M&A’s only generate competitive parity: – Ensure survival of acquiring firm

• Improve efficiency in line w/ competitors (e.g. banking)

– Deploy free cash flow (cash generation when NPV of current investment is declining) – may be preferable to dividends due to tax avoidance (consider proportion of owners’ brackets, capital vs. ordinary gain rules; e.g. pre- ’03, ‘03, ’08)

– Agency conflict • Managerialism: management perquisites; sizeà high TMT salaries • Managerial hubris

Why?

• “Target” firm seeks acquisition – After creating a business entrepreneur's personal wealth

may be tied up one or more firm which they control – This concentration of wealth carries risk (external threats) – Thus there may be a desire to cash out

• Alternatives (partial or full divestment through: • Business angels (often used to generate capital for growth rather

than cash out) • Venture capital firms (often used to generate capital for growth

rather than cash out) • IPO

Acquisition vs. Merger

• Merger: two firms are combined on a relatively co- equal basis – Less likely to be unfriendly

• Is the line between merger & acquisition always clear? – Firm sizes? – Whose equity is acquired? – Whose management is retained? – Who will dominate?

Acquisition vs. Merger

Merger Acquisition Parent stocks are usually retired and new stock issued

Can be a controlling share, a majority, or all of the target firm’s stock

Name may be one of the parents’ or a combination

Can be friendly or hostile

One of the parents usually emerges as the dominant management

Usually done through a tender offer

M&A Characteristics

• Friendly/Unfriendly/Hostile Takeover – Is a tender offer made w/ support of target’s TMT? – Does the BoD eventually approve?

• Potential Reponses to unfriendly acquisition attempts – Greenmail – management buys back potential acquirer's stake – Standstill agreements – Poison Pills – dividend to shareholders if acquired – Shark repellants – don’t hurt target firm value

• Super-majority voting rules • Pac-Man defense • Crown jewel sale • White knight acquirer

M&A Characteristics

• Related (FTC Classifications) – Vertical – Horizontal – Product Extension – Market Extension

• Unrelated – Conglomerate (Catch-all under FTC)

Lubatkin Sources of Strategic Relatedness (see Table 10.2)

• Technical economies – Scale economies that occur when the physical processes inside a firm

are altered so that the same amounts of input produce a higher quantity of outputs. Sources of technical economies include marketing, production, experience, scheduling, banking, and compensation.

• Pecuniary economies – Economies achieved by the ability of firms to dictate prices by exerting

market power.

• Diversification economies – Economies achieved by improving a firm's performance relative to its

risk attributes or lowering its risk attributes relative to its performance. Sources of diversification economies include portfolio management and risk reduction.

Unrelated M&As

• There would be no expectation of value creation due to the lack of synergies between businesses

• There might be value creation due to efficiencies from an internal capital market

• There might be value creation due to the exploitation of a conglomerate discount

Related M&As

• Value creation would be expected due to synergies between divisions – Economies of scale/economies of scope

• Transferring competencies, sharing infrastructure, etc.

M&As: Value Creation and Value Capture

• Based on empirical study, collectively: – Acquiring Firms

• No value increase – Target Firms

• Value increases by about 25% – Related M&A activity creates more value than

unrelated M&A activity

CA from M&As: Management Abilities

• Skill for recognizing & exploiting potentially value-creating economies with other firms

• Skill at initiating and completing ‘deals’

Doing the Deal

Bidding Firm’s Perspective

Search for Rare Economies

Limit Information to Other Bidders

Limit Information to the Target

Avoid Bidding Wars

Close the Deal Quickly

Seek Thinly Traded Markets

Competitive Advantage

Recognizing and Exploiting Economies of Scope

Private Economies

Firm A

Firm B

Firm C

• Firm C’s recognized value is $10,000

• Firm A can earn a profit of $2,000

only if the economy remains privateBidders Target

• Firm A sees value of $12,000 in Firm C

Competitive Advantage

Recognizing and Exploiting Economies of Scope

Costly-to-Imitate Economies

Firm A

Firm B

Firm C

Bidders Target

• if the economy between A & C

is costly to imitate, it doesn’t matter

if other firms know

• Firm A can still earn a $2,000 profit

Competitive Advantage

Recognizing and Exploiting Economies of Scope

Firm A

Firm B

Firm C

Bidders Target

Unexpected Economies

• Firm C has a market value of $10,000

• Firm A buys Firm C for $10,000

• Firm C turns out to be worth $12,000

Thinly Traded Markets

• Markets where: – There are few buys/sellers – Information on market opportunities is scarce – Maximizing value is not the sole interest of traders – [Competition is often at the local level]

Competitive Advantage

Target Firm’s Perspective

Seek Information from Bidders

Invite Other Bidders to Join in Bidding Contest

Delay, But Do Not Stop the Acquisition

Implementation Issues

• Structure, Control, and Compensation (M-form) • Level of integration/autonomy • Organizational/National Culture • Government Intervention

– Antitrust concerns – Foreign Ownership Concern

• Explicit constraint of ownership by foreign firms • Regulatory differences (e.g. labor) • Profit repatriation

Cultural Issues (National Culture)

Time OrientationLong-term Short-term

Goal OrientationAggressive Passive

Uncertainty OrientationAcceptance Avoidance

Power Orientation ToleranceRespect

Social OrientationIndividualism Collectivism

(Hofstede, 1980) See cultural dimensions: PDI, IDV, UAI, MAS, LTO, & IND

International Implementation Issues